The Fed's expected rate cut may be the only good news Wall Street gets for some time, says Andrew Hill Published: March 16 2001 19:53GMT | Last Updated: March 16 2001 20:01GMT Welcome to the I-told-you-so market. Like fickle citizens who claim to have been freedom fighters after the totalitarian regime falls, US stock market commentators have rushed to demonstrate in recent weeks how they spotted the collapse coming. With exquisite timing, Warren Buffett, one of the few US investors who can claim to have been part of the resistance all along, released his letter to shareholders of Berkshire Hathaway, the investment company he heads, last Saturday, on the first anniversary of the Nasdaq Composite's peak. A new wave of investors had learnt some very old lessons, he wrote: "First, many in Wall Street - a community in which quality control is not prized - will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest." Right now, nobody believes speculation is easy. The Nasdaq is down more than 60 per cent from its high of more than 5,000 and concern about the US economy has infected the wider market. The Wilshire 5000, the broad- based index of all publicly traded shares that Alan Greenspan, the Federal Reserve chairman, is said to watch, is 27 per cent below its peak. This week, the Standard & Poor's 500 joined it in bear market territory, down more than 20 per cent from its high, and the Dow Jones Industrial Average dipped below 10,000 for the first time in five months. The headline-grabbing slump in the main indices prompted even the president to worry publicly about US investors' well-being this week. "I'm concerned that a lot of Americans' portfolios have been affected," President George W. Bush said during a visit to New Jersey on Wednesday, but added: "I've got great faith in our economy." Mr Bush is not the only influential figure weighing up the stock market on one hand and the economy on the other. Mr Greenspan and his colleagues at the Federal Reserve will have to pay attention to both next week when they meet for the first time since the end of January to discuss monetary policy. "The US economy, while it has certainly slowed down considerably, has not fallen off a cliff," says Alan Skrainka, chief market strategist at St Louis-based Edward Jones. "The Nasdaq is down 60 per cent but the US economy isn't." Employment, retail sales and housing data released in the last two days indicate that the economy is stalling rather than diving into recession. The University of Michigan's consumer sentiment index - which most analysts had expected to fall further in March - rose slightly, according to figures circulated yesterday. "Clearly we see some slowdown but we don't see a recession, by any means," says Deborah Cannon, president of Bank of America in Houston, Texas. The evidence supports investors' expectations for a further half-point cut in interest rates next week. But most Wall Street economists and strategists believe the sharp decline in the markets in the past two weeks has increased the possibility the central bank will announce a three-quarter-point cut on Tuesday. Short-dated Treasury bonds and Treasury futures are also pricing in an aggressive easing in monetary policy. Part of the reason to expect a 75-basis-point cut is that the psychological damage caused by the daily attrition of stocks is beginning to have a self-fulfilling effect on the corporate economy. The impact is almost the reverse of what happened at the end of 1999 and beginning of 2000, when rapid increases in stock prices encouraged companies to invest in new capacity. "The collapse in the equity market and the volatility surrounding it probably are contributing to some retrenchment on the part of even healthy companies," says Robert DiClemente, US economist at Salomon Smith Barney. Since the end of last year, US companies have issued a steady stream of warnings about the business outlook. US companies announced more than 100,000 job losses in February, according to Challenger, Gray & Christmas, the outplacement company - almost three times as many as in the same month last year. This week Compaq, the computer-maker, became the latest company in the technology sector to announce job cuts on the assumption that economic weakness would spread beyond the US. With the first-quarter earnings season only a couple of weeks away, further warnings are expected. As a result, Wall Street is cutting back its forecasts for corporate earnings growth for the rest of the year. Edward Kerschner, strategist at UBS Warburg in New York, now expects first-quarter earnings to drop 15 per cent compared with the first three months of 2000 and full-year reported earnings to fall 2.7 per cent. But even he admitted, in a note published earlier this week, that the usual method of constructing earnings forecasts amounts to "a pooling of ignorance - strategists manipulating the estimates of analysts who are following the guidance of managements who are clueless about the near-term course of earnings". US companies' inability to see more than a few weeks ahead is also rattling fund managers. "Companies are out to protect their bottom line and so they are cutting and cutting, making an inventory correction into something far more serious," says Tom McIntyre, president of Dessauer & McIntyre Asset Management, which manages $500m of mutual funds. Adding to concern is the risk of global contagion. Rumours of strain in the Japanese banking system spooked European markets on Wednesday and put US equities under pressure. But so far there are surprisingly few signs of outright fear in the marketplace. Investors have poured more money into money market mutual funds but, according to anecdotal evidence, they have not started to flee equity funds. Treasury bonds - the traditional haven of risk-averse investors - have risen as the stock market has declined but there is little indication of a headlong rush to quality as there was in 1998 when the Russian financial crisis and collapse of Long-Term Capital Management precipitated a global liquidity crunch. The Fed can also take heart from the fact that the easing in monetary policy that began with a surprise rate-cut on January 3 has prompted a revival of lending activity by US banks and an increase in bond issuance by companies. But corporate bond traders still believe that this amounts to only a tentative reopening of the market. If caution turns to fear, banks may again squeeze credit, as they did at the end of 2000, stifling any signs of economic recovery. Policymakers are conscious of the risks. Lenders and their supervisors "should be mindful that in their zeal to make up for past excesses they do not overcompensate and inhibit or cut off the flow of credit to borrowers with credible prospects", Mr Greenspan told a banking conference this month. Unfortunately for equity investors, Tuesday's Fed decision will be only one positive element in an otherwise gloomy outlook for the broad stock market. A number of Wall Street strategists now argue that the bottom may have been reached but the main indices are still highly valued by historic standards and the most recent declines came after strategists from Morgan Stanley Dean Witter, Merrill Lynch and Goldman Sachs urged investors to increase their exposure to US equities last week. The Fed is also worried about the perception that it acts to put a floor under the equity market whenever Wall Street gets the jitters. That may be the reason why the central bank has shied away from making another interest rate cut between meetings - and could influence the decision on Tuesday. US equity investors may have to draw on a little more of their legendary resilience before the worst is over. _______________________________________________ CrashList website: http://website.lineone.net/~resource_base
